FASB proposal could lead to move away from mark-to-market, says Financial Times

It would be interesting to hear how this modifies the existing ability of banks to mark-to-model via Level 3 assets. It was my impression that banks already had some ability to mark-to-model with this classification.

Instead of saying only governments could save the banking system, I say the governments caused the problem by embracing and enshrining (through decades of Basle ministration and regulation) the ultra-high leverage banking business model. It's the leverage and the failure to match assets and liabilities that landed us where we are.

There is little doubt that current mark to market rules have contributed to the development of the credit crisis. We have been reminded that the trading price of an asset which everyone would like to sell at the same time but nobody wants to buy tends towards zero. That is true for structured credit, for houses, for tulips...you name it. The problem with credit assets in a financial system is that through asset writedowns the entities who supply credit to the economy, that is, the retail and wholesale banks, see their capital wiped out. With securitisation markets closed and banks desperate for capital, the lack of credit supply to the economy makes all credit assets riskier. At that point a negative feedback loop is established and a downward spiral sucks the economy down. If that feedback loop would not have been broken by government intervention, it could have taken the economy to an even deeper recession than the one we are experimenting. Of course there are many other factors that brought us where we are, we were ripe for a bear market in credit. But whoever bet against banks through CDS or shorting was long convexity due to the nature of the feedback loop mentioned before. Only governments (and not all of them, see Iceland) had the resources to stop the process.

The idea has merits but also many pitfalls. One problem is that it encourages the pro-cyclical behavior of levering-up during good times and falling back to the models in bad times. Also defaults do happen in bursts and recoveries do fall at these times; CDS writers can be caught naked in the tide of defaults and marking-to-model their positions would be small consolation.